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Roubini: Greece Should Default, Leave The Euro And Reinstate The Drachma

A Greek default looks increasingly likely. That seems to be the theme of the day as markets and commentators insist that the debt situation over in Europe is unsustainable . Among those calling for a default is Nouriel Roubini, who adds that Greece should exit the Eurozone and reinstate the drachma to avoid a decade-long recession.

“Greece is stuck in a vicious cycle of insolvency, low competitiveness and ever-deepening depression,” wrote the famous Roubini in an op-ed piece for the FT. Often dubbed Dr. Doom, the NYU economist made the case for a Greek Eurozone exit along with an orderly default, as markets increasingly seem to be pricing in the event.

“A Greek default looks to be imminent and markets seem to be bracing for the event,” explained Dave Rosenberg of Gluskin Sheff, citing inaction at a European Finance Ministers’ meeting in Poland, widening CDS spreads for Greece, Spain, and Italy, and the possibility that the next tranche of bailout funding for the beleaguered Hellenic nation might be delayed until mid-October. Rosenberg says a survey of economists puts the odds of a Greek default at 65%, “but only 20% believe the country will leave the Eurozone.” (Read Official Euro Document: Crisis Now Systemic As Bank Liquidity Problem Fuels Vicious Feedback Loop).

Roubini is among those that think Greece should indeed exit the Eurozone. Dr. Doom explains that without a return to growth, Greece’s debt situation will remain unsustainable. Further draconian fiscal austerity, along with insolvency and low competitiveness, will do nothing more than prolong a deepening recession-cum-deflationary depression for five to ten years.

Greece’s main problem, then, is one of competitiveness, and the only way to solve this, according to Roubini, as by reinstating the drachma. There are other ways for Greece to regain competitiveness, for example, the euro could be weakened substantially in order to provide relief to Greece and its fellow PIIGS, which appears “unlikely while the US is economically weak and Germany uber-competitive.”

Other options to restore competitiveness are equally untenable. Structural reforms that would bring down unit labor costs can take up to ten years, as the German experience has shown, while “rapid deflation in prices and wages, known as an ‘internal devaluation’ […] would lead to five years of ever-deepening depression, while making public debts more unsustainable,” wrote Roubini.

The only other option, then, is for Greece to leave the Eurozone in an orderly default, renegotiating the recent debt swap deal (which Roubini calls a “rip-off” because it actually provides near to no debt-relief given sweeteners offered to creditors), and an exit from the European Monetary Union. From his article:

Like a broken marriage that requires a break-up, it is better to have rules that make separation less costly to both sides. Breaking up and divorcing is painful and costly, even when such rules exist. Make no mistake: an orderly euro exit will be hard. But watching the slow disorderly implosion of the Greek economy and society will be much worse.

Reinstating the drachma won’t come at no cost, but it should restore competitiveness by causing a sharp depreciation in the new currency, along with a jump in the foreign euro liabilities of Greece’s government, banks, and companies, which would be coupled with a massive fall in the real purchasing power of Greeks. Core Eurozone financial institutions would suffer substantial capital losses, and these would need to be preemptively, and aggressively, recapitalized to avoid a crisis. (Read Central Banks’ Liquidity Bail Out For Euro Banks).

The Greek banking system would be pushed to the brink, and saved through “Argentine-style measures-such as bank holidays and capital controls [and a unilateral ‘drachmatization’ or conversion of all euro debts].”

Roubini responds by saying that “via nominal and real depreciation, the exit path will restore growth right away, avoiding a decade-long depressioanry deflation.” Dr. Doom consistently cites the case of Argentina, noting the South American nation did quickly bounce back into positive growth. (Argentina, though, had the benefit of being one of the world’s largest agricultural exporters and a decade of rising commodity prices). (Read What If Germany Seceded From The EU? 40% Appreciation And A Decimated Export Sector).

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